Discounting charges made for bills of exchange are not interest – Delhi HC

Delhi High Court in the case of DCIT v. Cargill Global Trading (I) (P) Limited on the issue of whether discounting charges paid to a non-resident on discounting of bills of exchange (BEs) can be characterized as ‘interest’, liable for withholding held that the discounting charges are not in the nature of ‘interest’ since they are not payable in respect of money borrowed or debt incurred by the Taxpayer. Accordingly, the discounting charges are business income, not covered by the special source rule applicable to interest income. As the recipient non-resident does not have a permanent establishment (PE) in India, it is not liable to tax in respect of such discounting charges and, consequently, the Taxpayer is not obliged to withhold tax from such payment.

Background and facts

The Taxpayer is in the export business. On exports made by the Taxpayer on credit terms, the Taxpayer draws BEs on the buyers for the sale value, with a maturity period of about six months. The Taxpayer discounts the BEs with its non-resident associate concern, a company that is a tax resident of Singapore (SingCo), on ‘without recourse’ basis. SingCo is engaged in the business of underwriting, acquiring, owning, selling etc., of securities, negotiable instruments, commercial papers etc., and has no presence in India.

On account of discounting on ‘without recourse’, SingCo purchases BEs on its own behalf and collects payment for itself on the due date and has no right to proceed against the Taxpayer even if there is default by the foreign buyer.

The difference between par value of BEs and the amount at which BEs are sold to SingCo represents discounting charges. Such discounting charges were claimed as tax deductible expenditure by the Taxpayer.

The term ‘interest’ is defined in the Indian Tax Laws (ITL), in a broad manner, to include interest payable in any manner in respect of any moneys borrowed or debt incurred. Under the ITL, ‘interest’ also includes any service fee or other charge in respect of moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized.

The characterization of payment as ‘interest’ attracts withholding obligation for the Taxpayer in terms of the provision of the ITL as also the provisions of the India-Singapore Double Taxation Avoidance Agreement (DTAA). Failure to withhold tax attracts disallowance in computation of business income.

The Taxpayer did not withhold tax on discounting charges on the basis that it did not represent ‘interest’, either under the ITL or under the DTAA.

However, the Tax Authority held that the discounting charges were in the nature of ‘interest’ and disallowed the claim by holding that the Taxpayer failed to withhold tax.

On appeal by the Taxpayer, the first appellate authority and the Income Tax Appellate Tribunal (ITAT) accepted the Taxpayer’s contentions and deleted the disallowance. Aggrieved by the ITAT’s ruling, the Tax Authority preferred an appeal before the HC.

‘HC’s ruling

The HC held that the discounting charges were not in the nature of ‘interest’, attracting withholding obligation, for the following reasons:

Payment of ‘interest’ presupposes borrowing of money or incurring of debt. Discounting of BEs does not involve borrowing of money or incurring of debt. The BEs were acquired by the purchaser at a discounted price and there was no debt or obligation incurred by the Taxpayer in favor of the purchaser of the BEs.

The HC noted, with approval, the following reasoning adopted by the ITAT in allowing the Taxpayer’s claim:

The definition of ‘interest’ in the Interest Tax Act specifically includes discount on promissory notes and BEs drawn or made in India. Such extended coverage is absent in the ITL and the DTAA definition of ‘interest’ which supports that but, for such specific reference, ‘interest’ does not include discounting charges within its scope.

Circular No. 65 dated 2 September 1971, issued by the Central Board of Direct Taxes (CBDT), clarified that, in cases of discounting of usance bill/BEs, the net payment made by the bank to the drawer of the BEs is in nature of a price paid for purchase of BEs. This circular clarified that discount amount cannot be regarded as ‘interest’ and, therefore, no tax is required to be deducted at source by the drawer.

As per the Supreme Court (SC) decision in the case of Vijay Ship Breaking Corpn. v CIT [219 CTR 639], there is no withholding obligation for the taxpayer if the amount is not chargeable to tax in India.

The discounting charges were not in the nature of interest paid. Rather, after deducting discount, SingCo received the net amount of the BEs accepted by the purchaser. As SingCo does not have a PE in India, it is not liable to tax in respect of such discount earned by it and, hence, the Taxpayer is not under obligation to deduct tax at source under Section 195 of the ITL.

The HC also referred to the CBDT Circular No. 647 dated 22 March 1993 and noted that, as per clarification provided by this circular, the difference between the issue price and face value of commercial papers (CPs) and certificates of deposits (CDs) is to be treated as ‘discount allowed’ and not as ‘interest’ and no tax is required to be deducted on such discount.

The HC eventually concluded that no substantial question of law arises since the matter is settled by the SC decision (supra) as also the CBDT circulars and the appeal was dismissed.

Comments – This ruling provides guidance that discounting charges of BEs do not represent ‘interest’ and, hence, do not attract withholding obligation for the taxpayer. Incidentally, the Authority for Advance Rulings, in the case of ABC International Inc., on identical facts, reached a similar conclusion.

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